"If You Start Me Up, I'll Never Stop"

Posted on March 09, 2005
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Entrepreneurs are a hardy bunch. They may start their own businesses for a variety of reasons, weathering any number of adverse conditions to make it work. One thing they have in common is a willingness to take risks. Lots of people have good ideas, but how exactly do we encourage people to turn those ideas into businesses? One way is to cut taxes.

According to a recent study, "a reduction in the marginal tax rate on entrepreneurial income of one percentage point would increase probability of entry into entrepreneurial activity by 1.42 percentage points for single filers and 2.0 percentage points for married filers." Perhaps more interesting however, are what tax burdens do to active entrepreneurs. "A marginal tax rate reduction of one percentage point on entrepreneurial income reduces the probability of exiting entrepreneurial activity by 17.32 percentage points for single filers and by 7.81 percentage points for married filers."

The study, Taxes and Entrepreneurial Activity: An Empirical Investigation Using Longitudinal Tax Return Data, released by the U.S. Small Business Administration's Office of Advocacy, examines the relationship between marginal tax rates and individuals' decisions to start their own businesses and. It shows that even minor increases in tax burdens can suppress a significant amount of entrepreneurial activity.

Entrepreneurship is an inherently risky endeavor, and people willing to go into business for themselves discover a variety of innovative ways to both mitigate those risks and accept them. As we all know, however, taxes are an unavoidable dampener on the incentive to engage in self-employed activity even the best new product will be disincentivized by taxes. So it behooves policymakers to consider all the would-be start-ups they are forgoing when they increase tax burdens. Moreover, they should consider the liberating effect of decreasing tax burdens, unleashing latent entrepreneurial talent.

That a person can have a great idea, the ingenuity to turn it into a business idea, and the drive to put in the hard work to get it done, only to be foiled by the marginal tax rate, it's enough to "make a grown man cry."

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